As the problems of the Equity Programs Investment Corp. (EPIC) have been revealed in recent days, much attention has been focused on the big institutions that own EPIC mortgages and on the insurance companies that wrote policies on them.
But the system that propelled EPIC from nothing 10 years ago to an empire of 20,000 single-family homes today involved another class of investors: individuals, not necessarily wealthy ones, who bought into real estate investment partnerships set up by the company.
They could turn out to be the EPIC saga's biggest losers.
In the negotiations between EPIC and the mortgage insurers and big Wall Street investment firms that are advising them, the individual investors appear to be without an advocate. And several sources familiar with EPIC's operations have said they do not see any possible bailout that would give these investors their money back.
Some are known to be retaining lawyers and considering legal action, but it is not certain that there will be anything left for them to recover after the crisis is resolved. Also, it appears from records seen by a reporter that at least some of the investors will realize tax benefits large enough to make up for their losses.
The crisis began with the disclosure Aug. 16 that EPIC was delinquent on some payments due on mortgages and mortgage-backed securities.
Only EPIC knows for sure how many investors still own interests in its partnerships, and company officials have not been returning telephone calls. But at its height the company was generating partnerships at the rate of more than 100 a year, usually with around 25 "units" offered for sale. An investor might buy one or more units.
However, in recent years, according to sources familar with the company, EPIC has been selling so-called "expandable" partnerships in which new groups of investors are brought in every six to nine months. These partnerships appear to have been sold as pure tax shelters without any serious prospect of profit, but several sources noted that if EPIC has to liquidate, these investors could face substantial tax bills.
Their situation is particularly precarious because of the way the partnerships were structured.
Their purpose was to buy single-family homes, rent them, take the tax benefits, and eventually sell them to recover their capital and possibly make a profit.
But while most started out with a cash cushion, they generally ran at a deficit. EPIC, the general partner, made up the difference with loans.
So as time passed, partnerships steadily added debt. This debt could be paid off and investment money returned only if the houses could be sold at a big profit.
Several former EPIC officials have said that this did not happen very often. They added that in cases where appreciation was substantial, properties were sometimes refinanced, sharply reducing the partnership's equity.
Investors were recruited through financial advisers and regional brokerages. The partnership interests were sold as what is known as private placements. Under securities regulations, such offerings are meant to be aimed at relatively small numbers of sophisticated, relatively well-to-do investors.
At the end of each year, EPIC provided completed K-1 tax forms ready to be plugged into the investor's return.
One set of K-1s examined by a reporter showed a $25,000 investment generating write-offs of $31,000 last year and just under $26,000 the year before. Thus, an investor in the 50 percent tax bracket would have recovered the investment in tax savings in two years.
However, a recent investor, or one in a lower bracket, might not fare as well.
Tax benefits such as these, which were made possible by a tax law change in 1981, were the key to EPIC's rapid growth, according to former company officials.
A decade of rapid inflation had pushed many middle-class people into higher tax brackets, sharply expanding the market for tax shelters. The 1981 Economic Recovery Tax Act allowed much larger depreciation write-offs in the early years of real estate ownership. The combination has spawned a huge industry known as real estate syndication, the device used by EPIC. But because single-family homes usually rent for much less than the cost of ownership, syndicators generally limit themselves to office buildings and other commercial property.